Almost a year ago I predicted that come September - October of 1999 there would be a decline in the market. Almost on cue the market dropped then rallied for the year end boost. Almost a year ago I also predicted that that decline would carry over into the new year and would begin to feed on itself. I was a bit off on that part but not by much.
A few days ago the Dow Jones Industrial Average (DJIA) was down over three hundred points (almost four hundred would be closer to the truth). The Nasdaq Composite Index (NCI) was up around fifty points, surpassing the five thousand mark for the first time in history.
What's my prediction for the rest of the year? More of the same followed by more of the same.
You're probably thinking that the above prediction is a cop-out and you're right. I'm trying to prove a point. For all their education and experience, financial advisors and their ilk are no better at predicting the movement of the market than you or I. In fact, in numerous informal studies, it has been shown that using the dartboard approach to pick stocks can yield just as good results, if not better, than following the advice of the professionals.
Does this mean that you should never listen to financail advice from the experts? No. All it means is that you should do your own research to determine if what they are saying is valid and if so, is it good for you. I'll give you a good example.
Every weekday morning the Bloomberg financial news show is on while I get ready for work. Every morning I get a good dose of the world and national news coupled with loads of ideas for investments. During this program they have experts from the industry come on and explain how they pursue investment ideas and what their strategies are. One underlying theme during the last six months or so has been if and/or when a bear market will occur.
For those of you under the age of twenty who have yet to experience a bear market, here's a brief definition. The market goes down and stays down. You don't get to day trade in a bear market.
The decline in the DJIA from its high of over eleven thousand to now below ten thousand would seem to indicate a bear market is at hand. After all, that is a decline of over fifteen percent, the classic definition of either the beginning of a bear market or a correction, depending on who you listen to.
The one thing that the experts seem to overlook is the fact that in todays economy, one cannot use the markers of old to predict the future path of the market. By that I mean you cannot use the thirty stocks of the Dow Jones Industrial Average, even if they have been updated, to gauge where the market will be. Thirty stocks can no longer be used as a barometer of market conditions. The sampling is just too small. You wouldn't take the results of a poll which used thirty people as its sample as predictive of the overall opinion of a community would you?
A better predictor would be to use a much larger sampling. This would provide a much broader base of opinions on which to base your conclusion. Such a sampling exists in the financial markets, the S&P 500. This index has, as its name implies, five hundred stocks within its fold. These companies represent nearly every industry in the US and thus, a much better indicator of the overall state of the financial community.
So what does this index predict for the future? To be honest, not much. While in 1999 this index flew through the roof, as did most indices and a fair portion of all stocks, currently it is searching for a path. During the first two months of this year it is up only a few percentage points. Average it out over the course of the year and you get an average return of about twelve percent. Not much by recent standards.
Having gone through the above dissertation on how to judge market predictors, what is my real prediction for the coming year? The Dow Jones Industrial Average will decline to around nine thousand five hundred before it recovers and ends the year somewhere in the mid ten thousands (10,300 - 10,700). The S&P 500 will continue its creep and crawl upwards and will end the year with about sixteen percent gain. The Nasdaq Composite, however, will continue its march onward racking up a gain of over thirty-five percent.
A final note of caution. The rise in stock and mutual fund prices has been accompanied by an ever increasing amount of debt and margin as people try to squeeze as much gain as they can out of their investments. By debt I mean the use of credit cards and the like to buy things because people see their investments going through the roof and believe that they have this money to spend when in actuality its all paper profits. They haven't actually sold the stock to get the money.
By margin I mean borrowing money from the broker to buy stock in the anticipation that it will go up. You then sell the stock, pay back your loan to the broker minus interest and pocket the difference. Sounds simple. The only problem is, if the stock goes down and you don't get out quickly enough you not only loose money on your investment but you have to put up money to cover your margin, otherwise known as a margin call. If you don't have the cash, the broker starts liquidating until your debt is covered. Selling drives down prices because there is more of a supply of stock, basic economic theory.
If either of the above conditions begin to take hold, either people having to sell stock or mutual funds to pay their credit card debt or margin requirements, all bets are off. I could reasonably see a market downturn of up to twenty-five percent if people start selling. By market downturn I mean specifically the DJIA although the Nasdaq will weather things a bit better with only a fifteen percent decline.
Let's be realistic. Everything that goes up must come down. There is not enough wealth in this nation to continue the ballistic rise in stock prices forever. At some point money will be pulled out of the market whether it be to take profits or, as will be the more likely scenario in the coming decade, people retire. As the population ages, prices will decline as they withdraw their savings to pay their bills. When that happens, a true bear market will happen.